Treasuries not good enough as swaps collateral in CFTC rule

The revised treatment of Treasuries as collateral would also apply when they are pledged to protect futures trades at U.S. clearinghouses.

While the CFTC vote would finalize the detailed version of the mandate, it wouldn’t guarantee the Fed’s interpretation prevails. Fed officials will accompany the CFTC during oversight and enforcement reviews of derivatives clearinghouses, and central bankers could insist on proof that lines of credit back the Treasuries posted as collateral, according to one person familiar with how the process works.

The Dodd-Frank Act required most swaps to be backed by clearinghouses for the first time after the contracts helped cause and intensify the credit crisis of 2008. That means swaps users will have to post $800 billion to $4.6 trillion in additional collateral at clearinghouses to meet the new regulations, according to estimates from the Treasury Borrowing Advisory Committee.

Sweeping Changes

Stiffening funding requirements for Treasuries would be the latest in a series of actions taken by regulators to rein in the swaps market, frequently to the dismay of traders who say the rules make it unreasonably difficult to do business. The goal is to avoid meltdowns like the ones in 2008 that triggered American International Group Inc.’s $182 billion bailout after the insurer couldn’t make good on its trades and almost destroyed the world’s biggest banks.

CME Group, the operator of the world’s largest futures market, said the proposal risks damaging the perception of U.S. national debt as easy to buy or sell, according to a Sept. 16 comment letter to the CFTC from Kim Taylor, president of company’s clearinghouse.

“To assert that U.S. Treasuries can only be considered ‘liquid’ to the extent that they are utilized with pre-arranged and highly reliable funding arrangements is to assert that the liquidity of U.S. Treasuries is ‘zero,’ which seems unnecessarily extreme,” Taylor said in the letter.

Most Natural

Treasuries are the most natural form of collateral for banks and their customers to use to back derivatives trades, CME Group’s Taylor said.

“Treasuries are normally very easy to convert into cash on a same-day basis” even if “the cash need not arrive until the end of the day,” Darrell Duffie, a finance professor at Stanford University, said in an interview. While CME Group survived multiple rounds of margin calls over a single day after the 2008 bankruptcy of Lehman Brothers Holdings Inc., one of the largest derivatives dealers at the time, “I suspect it was a tense day,” Duffie said. Having assured access to cash in place of Treasuries could be important for the industry, he said.

The Futures Industry Association, a trade and lobbying group for the banks that act as brokers in the industry, asked the CFTC to allow Treasuries to be pledged without any financial backing, according to a Sept. 20 comment letter to the CFTC.